If these proposed regulations become law, business owners may lose the ability to use valuation discounts of ownership shares as an estate planning technique.
Have you arrived at that time when retirement is no longer off in the future but just around the corner? If that is the case, and if you are a business owner thinking about succession planning and estate planning, you need to know about a significant change being proposed by the IRS and the Treasury. Many business owners transfer their interest in the business to their children, but this option is likely going to end soon.
A recent cincinnati.com post, “Planning can minimize bite on business from estate tax,” explains that the IRS recently released proposed regulations that would close the tax loopholes some taxpayers use to minimize gift and estate taxes when transferring interests in a closely held family business to relatives.
If a person wants to transfer a minority interest to his or her children, there are the tax advantages of “discounts” that help preserve the owner’s lifetime exemption. Discounts usually range between 25 percent and 40 percent and fall into two categories: minority discounts and lack of marketability discounts. The reason to apply discounts in situations where a minority interest is transferred is that an ownership position with less than 50% of the voting rights lacks the ability to control. There are quite a few things a majority owner can control that a minority member can’t—like setting management compensation, creating policies, deciding the amount and timing of distributions, and liquidating, dissolving or selling the company.
Using discounts in tax and estate planning can create a big benefit and allow for greater transfer of wealth to family members. So, if you wanted to transfer a minority interest in your business to your children with a value of $1 million, a discount of 30% would mean that you would only have to reduce your lifetime exemption by $700,000 instead of $1 million.
If you think your estate will be under the $5.45 million or $10.9 million exemption amount, you should weigh the desire to transfer the business with the potential to step-up the basis upon your death. Based on the business structure, your current basis may be significantly less than the business’ current value. Any gifts made of the business interest would have carryover basis for the recipient. If the owner died owning the business, the recipient would get a basis that’s generally equal to the fair market value as of the date of death—a difference that can be valuable if you have a low basis and if you don’t otherwise anticipate owing estate tax.
The proposed regulations are now in a period of public comment, and a public hearing is scheduled for December 1. If they become law, they won’t take effect until at least 30 days after being finalized—so there is a very very small window of time left to use this estate planning technique. If this is something that applies to your estate plan and succession plan, meet with an estate planning attorney as soon as possible.
Reference: cincinnati.com (August 31, 2016) “Planning can minimize bite on business from estate tax”